How Changes In Oracle’s EBITDA Margin Impact Its Stock Price
Software giant Oracle (NYSE:ORCL) has reported a strong revenue growth for its cloud services segment, which includes SaaS (Software-as-a-Service), IaaS (Infrastructure-as-a-Service) and PaaS (Platform-as-a-service) offerings. Meanwhile, the company’s core on-premise software deployment revenues (and subsequently hardware and services revenues) have slowed down in recent years. In order to minimize the impact of slowing revenues in its core business, Oracle’s management has taken measures to restrict the increase in operating expenses. Oracle’s adjusted R&D expenses in 2017 were roughly flat over 2016 levels at $5.6 billion, while adjusted SG&A expenses fell 2% y-o-y $7.5 billion. Please note that we adjust these expenses for non-cash expenses such as depreciation, amortization and stock-based compensation.
Margin Expansion
As a result of the minimal increase in operating expenses complemented by strong revenue growth, Oracle’s adjusted EBITDA margin expanded by 140 basis points in 2017 to 46.2%. We forecast the company’s adjusted EBITDA margin to improve by 1 percentage point through 2018. However, there can be two scenarios where the margins can improve further and reach 2012-2013 levels of around 48%. Firstly, if Oracle continues its headcount reduction program that it undertook last year, particularly for sales employees. Secondly, the company remains committed to achieving long-term gross margins of around 80% and reported a 7 percentage point improvement in SaaS gross margins last year. However, gross margins of the IaaS and PaaS segments have remained as the company expands geographically. However, with aggressive expansion, Oracle could hit its targeted gross margin range sooner than anticipated.
Needless to say, Oracle’s ability to improve EBITDA margin and increase profitability is important for its valuation. We have created an interactive model that details how a change in its EBITDA margin can impact the company’s value. You can modify assumptions such as expected revenue or improvement in EBITDA margin to see how the EPS or estimated valuation changes. The image below shows one of the key steps in identifying Oracle’s stock sensitivity to change in its EBITDA margin. We detail how change in margins impacts revenue, which then impacts EPS and subsequently the valuation (assuming the P/E multiple doesn’t change).
We find that an additional 1.1% increase in Oracle’s EBITDA margin would imply a 2.4% upside to its near-term valuation, which we estimate using projected EPS and a forward P/E multiple. Our sensitivity analysis assumes that the increase in EBITDA margin would not impact Oracle’s forward P/E multiple, which currently stands at 18.6 based on Trefis estimates (P/E based on Non-GAAP EPS). However, if you disagree with that assumption, you can make changes to all input variables on the interactive dashboards platform to gauge the impact of all changes on our price estimate and EPS.
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